Cetak A4 - IJBF6(2)09.indd
The International Journal of Banking and Finance, 2008/09 Vol. 6. Number 2: 2009: 77-93 77
IJBF RISK-ADJUSTED RETURNS OF
AMERICAN DEPOSITARY RECEIPTS
ON CHINESE AND INDIAN STOCKS
Onur Arugaslan and Ajay Samant
Western Michigan University
Abstract
This study evaluates the risk-adjusted performance of American Depositary
Receipts (ADRs) on shares of stock of Chinese and Indian fi rms. The fi rst part of
the study examines the nature of Chinese and Indian ADRs (based on depositary
bank, sponsorship status, industry classifi cation and listing). The second part of
the study evaluates the performance of these ADRs using statistical measures
grounded in modern portfolio theory. Returns are adjusted for the degree of
total risk and systematic risk inherent in each ADR, and the securities are then
ranked on the basis of risk-adjusted performance. Two relatively new evaluation
metrics, the Modigliani and Sortino measures, are used. The objective of the
study is to provide documentation to global investors who are contemplating
participation in Chinese and Indian stock markets via depositary receipts.
Keywords: ADRs, Portfolio choice, Investment decisions, Emerging markets
JEL Classifi cations: G15, G11, F30
1. Introduction
There has been a signifi cant rise in investor comfort over the past decade with
global fi nancial securities, aided by the ease and convenience with which
transnational corporate information can be accessed via the internet and other
means. One of the most convenient vehicles for accessing corporate securities
listed outside the investor’s home country is a Global Depositary Receipt. In
the United States, these securities are known as American Depositary Receipts
(ADRs). As of August 2007, there were 1,703 ADRs listed on the New York
Stock Exchange (NYSE), American Stock Exchange (AMEX), the NASDAQ
system, and on private trading networks.
This study examines the nature and performance of ADRs on shares of
fi rms incorporated in China and India. As is well known, China and India are the
two largest countries in the world in terms of population, and each country has a
ht
tp
://
ijb
f.u
um
.e
du
.m
y
78 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
diversifi ed industrial base, a rapidly growing consumer market, and an emerging
stock market. Table 1 summarizes information such as market capitalization,
gross domestic product, and labor force for these two countries. As a result of
excellent growth opportunities evident in those numbers, each of these countries
is under increasing scrutiny by international investors.
Table 1: Summary Economic Measures for China and India
China India
Market Capitalization ($ million)* 780,763 553,074
Value Traded ($ million)* 586,301 443,175
Number of Listed Domestic Companies* 1,387 4,763
Average Company Size ($ million)* 562.9 116.1
Gross Domestic Product (GDP) ($ billion)** 2,518 804
GDP Growth (2005-2006) 10.7% 9.2%
Average GDP Growth (1990-2006) 9.8% 6.1%
Labor Force (million)** 798 509.3
* 2005, ** 2006
Many of these investors fi nd it inconvenient, for a variety of reasons, to
invest directly in stock markets in China and India, and, therefore, prefer to invest
in ADRs based on Chinese and Indian stocks. These ADRs may be created at the
request of investors or corporations whose stock is held in trust as collateral for
the ADR. These securities serve a dual purpose: they enable fi rms incorporated
in China and India to raise funds in developed capital markets without having to
meet the stringent listing requirements of U.S. and European stock exchanges,
and, at the same time, enable global investors to earn returns on securities listed
on emerging markets without the dual inconvenience of having to deal with time
difference between countries and with currency conversion.
This study examines the nature of Chinese and Indian ADRs, sorted on
basis of depositary bank, sponsorship status, industry classifi cation, and stock
exchange on which the security is listed. Data are obtained from the Bank of
New York and CRSP. The intent of the study is to provide documentation to
international investors who would like to hold ADRs from China and India in
their global portfolios. The study should be of interest to international investors,
managers of mutual funds who are exploring opportunities to diversify their
global portfolios, managers of corporations who are planning to sponsor the
issue of depositary receipts, and to bank managers who provide international
fi nancial services.
The primary securities that underlie an ADR may be corporate stocks or
bonds. The earliest ADRs (1927) were issued at the request of institutional
investors. These ADR are “unsponsored.” Most of the ADRs that are currently
listed are “sponsored” programs, issued at the request of the fi rm whose securities
underlie the ADR. When a sponsored ADR is issued, there may or may not be
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 79
a corresponding creation of new capital. There are four grades of sponsored
ADRs. Level I ADRs are trade in the OTC market. Level II ADRs trade on
national stock exchanges (such as the NYSE). If new capital is raised during the
process of issuing sponsored ADRs, then the ADRs are categorized as Level III
and IV. Level III ADRs are listed on national stock exchanges. Level IV ADRs
are privately listed, and are usually issued under rule 144A of the US Securities
and Exchanges Commission.
This study examines the nature and performance of ADRs on Chinese
and Indian fi rms. The rest of the paper is structured as follows. Section 2 reviews
the literature on ADRs and summarizes pertinent studies in the area of modern
portfolio theory. Section 3 examines the sponsorship status, choice of depositary
bank, industrial classifi cation, and market listing. Section 4 evaluates the
performance of these ADRs on a risk-adjusted basis, using the Morgan Stanley
Capital International (MSCI) Europe, Australasia, and Far East (EAFE) Index as
a benchmark for comparison purposes. Section 5 concludes the paper.
2. Literature Review
Treynor (1965), Sharpe (1966), and Jensen (1968) pioneered the evaluation of
the performance of investment portfolios. They developed statistical techniques
that are the most commonly used portfolio performance measures even today.
Treynor (1965) suggested a way of evaluating the performance of a portfolio by
adjusting the mean excess return for the degree of market risk and thus calculating
the performance of the portfolio. Sharpe (1966) computed mean excess return
and adjusted for the degree of total risk involved in the portfolio. Jensen (1968)
devised a method of determining whether the deviation of portfolio returns
from market returns was statistically signifi cant, and, therefore, determining
whether the excess return could be attributed to superior management, or purely
to chance. The techniques used in these three pioneering studies were further
refi ned by Kon and Jen (1979), Henrikkson and Merton (1981), and Chang and
Lewellen (1984).
Later on, Modigliani and Modigliani (1997) did some pioneering work
in the area of fi nancial reward and risk. They proposed a new risk-adjusted
performance measure (hereafter referred to as, M Squared), which is intuitively
quite appealing to investors. The idea that underlies their methodology is
to adjust the returns of a portfolio to the level of risk in an unmanaged stock
market index and then measure the returns on the risk-matched portfolio.
Separately, academicians and practitioners in fi nance have shown an interest in
downside risk measures for evaluating portfolio performance. The most widely
cited performance measure that adjusts for downside risk is the Sortino Ratio
(Sortino and Price, 1994). In this paper, we use a modifi ed Sortino Ratio that was
introduced by Pedersen and Satchell (2002), who show that this ratio has a sound
theoretical foundation.
Academics have studied the benefi ts of global diversifi cation of investment
portfolios extensively. Solnik (1996) presents an excellent summary of these
ht
tp
://
ijb
f.u
um
.e
du
.m
y
80 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
benefi ts. Offi cer and Hoffmeister (1987) show that portfolio risk can be reduced
signifi cantly by including ADRs in a portfolio of purely domestic (U.S.)
securities. Aggarwal, Dahiya, and Klapper (2005) analyze the investment
allocation decision of mutual fund managers to invest in emerging market
fi rms that are listed in their domestic markets and have issued ADRs in the
U.S. as well. They fi nd that ADRs are the preferred mode of holdings if the
local market of the issuer has weak investor protection, low liquidity and high
transaction costs, and if the fi rm is small and has limited analyst following. The
motivation for cross-listing shares on foreign exchanges has also been widely
researched (Saudagaran, 1988). Umutlu, Salih, and Akdeniz (2007) investigate
the consequences of cross listing and fi nd that ADR listing does not have any
effect on the volatility of the underlying stock. On the other hand, Jaiswal-Dale
and Jithendranathan (2001) report that the ADRs capture the fl uctuations of both
the domestic and U.S. markets.
The relation between the price of ADRs and the underlying shares
has also been studied thoroughly (Alexander, Eun, and Janakiramanan, 1987;
Alexander, Eun, and Janakiramanan, 1988). Jayaraman, Shastri, and Tandon
(1993) study the impact of international cross-listings using ADRs. Because
ADRs can be exchanged for the underlying shares, fi nancial arbitrage usually
ensures that the price of an ADR is within transactions costs of the price of the
underlying share. Interestingly, in a recent study Eichler and Maltritz (2008)
develop an options-based approach to model the probability of a currency crisis
as a function of the deviation of the ADR price from the price of the underlying
stock.
To the knowledge of the authors, th is is the fi rst study of the nature
and performance of ADRs on Chinese and Indian fi rms, particularly, their
sponsorship status, industrial classifi cation, names of banks that are active in this
business, and exchanges on which these ADRs are listed. This is also the fi rst
rigorous study of the returns that have accrued to these ADRs, from the point
of view of US based investors. The results of this study should be of interest
to investors and mutual fund managers who are looking for opportunities to
diversify their international portfolios, to managers of Chinese and Indian fi rms
who are contemplating sponsoring the issue of these securities in US markets,
and to the managers of banks, which provide international fi nancial services.
3. Nature of ADRs from China and India
As of November 2006, there were 73 ADR issues on Chinese fi rms and 88 ADR
issues on Indian fi rms, listed on U.S. capital markets. All ADRs from China
and India were sponsored. Regarding the fi nancial institutions that have issued
the Chinese ADRs, the Bank of New York accounted for 50 of these issues,
followed by Citibank with 11, J.P. Morgan Chase with 10 issues, and Deutsche
Bank with two issues. Thirty-six ADRs from India were issued by the Bank of
New York, 25 by Citibank, 21 by Deutsche Bank, and six by J.P. Morgan Chase.
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 81
Regarding the exchanges on which these securities are listed, of the 73 Chinese
ADRs, 20 were listed on NASDAQ, 18 were listed on the NYSE, 27 were listed
on OTC (other than NASDAQ), and 8 were listed on Portal. Ten ADRs from
India were listed on the NYSE, three were listed on NASDAQ, 73 were listed on
Portal, and the other two were OTC.
Regarding industrial classifi cation, 8 of the Chinese ADRs were in
the software and computer services industry; 7 in travel and leisure; 5 each in
mobile telecommunications and technological hardware and equipment; 4 each
in industrial engineering, industrial transportation, and real estate; 3 each in
chemicals, electricity, life insurance, industrial metals, and oil and gas producers;
2 each in automobiles and parts, food producers, health care equipment and
services, leisure goods, mining, and pharmaceuticals and biotechnology; 1 each
in beverages, construction and materials, electronics and electric equipment,
fi xed line telecommunications, gas, water, and multiutility, general retailers,
media, oil equipment, services, and distribution, and support services.
With respect to industrial classifi cation, 12 of the Indian ADRs were in
the software and computer services industry; 9 in chemicals, 7 each in banking
and construction and materials; 6 in personal goods; 5 in industrial engineering;
4 each in fi xed line telecommunications, food producers, general fi nance, and
pharmaceuticals and biotechnology; 3 each in electricity, electronics and electric
equipment, industrial metals, and technological hardware and equipment; 2 each
in industrial transportation and travel and leisure; 1 each in automobiles and
parts, beverages, food and drug retailers, forestry and paper, gas, water, and
multiutility, general industrials, health care equipment and services, household
goods, oil equipment, services, and distribution, and support services. All data
are obtained from the website of the Bank of New York.
4. Performance of ADRs from China and India
A. Data and Methodology
Monthly return data for the three-year period January 2003 - December 2005 are
obtained from CRSP. Bank of New York ADR Index includes 35 ADRs from
China and 12 ADRs from India. CRSP has full return data for 14 Chinese ADRs
and 9 Indian ADRs. Therefore, the fi nal sample for the performance analysis
consists of 23 ADRs. The return on U.S. 4-week Treasury Bills is used as the
proxy for the risk-free rate. The MSCI EAFE Index is utilized as the market
benchmark.
Monthly returns are averaged over the three-year period to obtain
the Mean return. Risk-free rate of return is subtracted from the mean return to
compute the Mean excess return. Mean excess return of each ADR is divided by
its standard deviation to compute the Sharpe measure:
(1)i
R f-Ri
=S i
ht
tp
://
ijb
f.u
um
.e
du
.m
y
82 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
where R
i
= mean return on ADR i,
R
f
= mean risk-free rate of return, and
s
i
= standard deviation of returns for ADR i.
Mean excess return of each ADR is divided by its beta to obtain the
Treynor measure:
(2)
where b
i
is estimated from the market model:
where R
mt
= market return during period t, and
e
it
= error term.
Expected return of each ADR is subtracted from its actual mean return
to compute Jensen’s Alpha:
(3)
where the expected return for each ADR is obtained using the Capital Asset
Pricing Model:
(4)
Jensen’s Alphas are then tested for statistical signifi cance.
Mean excess return for each ADR is divided by the downside deviation
of that ADR’s return from the risk-free rate of return to compute The Sortino
Ratio:
(5)
where the downside deviation
is estimated as follows:
(6)
Sharpe measure is multiplied by the market standard deviation and then
the risk-free rate added to calculate the M Squared measure:
(7)
i
R f-Ri
=T i
e+R+=R itmtiiit
][R iERi=i
)(][ R f-RmiRR iE f
DDi
R f-Ri
=SOi
2
1
1
]2}),0(max{
1
1
[DD
n
j
R ijR fni
R f+m
i
R f-Ri
=M i
2
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 83
Finally, the benchmark standard deviation is divided by the ADR standard
deviation to obtain the Leverage Factor:
(8)
Leverage Factor reports a comparison of the total risk in the ADR with the
total risk in the market portfolio. For example, a Leverage Factor less than one
implies that the risk of the ADR is greater than the risk of the market index, and
that the investor should consider unlevering the ADR by selling off part of the
holding in the ADR and investing the proceeds in a risk-free security, such as
a Treasury bill. On the other hand, a Leverage Factor greater than one implies
that the standard deviation of the ADR is less than the standard deviation of
the market index, and that the investor should consider levering the ADR by
borrowing money (if possible, at the risk-free rate of return) and investing in
that particular ADR.
B. Results
The 23 ADRs with full monthly return data are identifi ed in Table 2 along with
their risk, return, and performance statistics. Returns, of course, are reported in
US dollars. The ADRs are ranked in alphabetical order for each country and
Chinese ADRs are listed fi rst, followed by Indian ADRs. The ADR with the
highest mean return is Rediff.com India with an average monthly return of
10.63 percent. Aluminum Corporation of China leads the Chinese ADRs with an
average monthly return of 6.23 percent. In comparison, the monthly mean return
of the benchmark MSCI EAFE Index is 1.83 percent. The ADR with the highest
total risk (measured by the standard deviation of returns) is again Rediff.com
India with a monthly standard deviation of 25.59 percent. The Chinese ADR
with the highest monthly standard deviation (18.74 percent) is Netease.com. In
comparison, the standard deviation of the benchmark MSCI EAFE Index is 3.51
percent.
Further, Table 2 reports the numerical values of the Sharpe and Sortino
measures, which are used to rank the ADRs in Table 3. The highest Sharpe
and Sortino measures obtained (0.48 and 1.14) are by HDFC Bank from India.
The highest Sharpe measure (0.42) for the Chinese ADRs is by CNOOC (China
National Offshore Oil Company) and the highest Sortino measure (1.12) is by
PetroChina. In comparison, the Sharpe measure and the Sortino measure of the
benchmark MSCI EAFE Index is 0.48 and 1.05, respectively.
Table 2 also reports the values of ADR Betas, M Squared measures,
Jensen’s Alphas (and their t-statistics), and Treynor measures, all of which are
computed using the benchmark MSCI EAFE Index. The ADR with the highest
systematic risk (Beta=2.14) is Aluminum Corporation of China. The Indian ADR
with the highest Beta (1.89) is Videsh Sanchar Nigam. In comparison, the Beta
of the benchmark MSCI EAFE Index is, by defi nition, exactly 1.0. The ADR
with the highest M Squared measure (1.83) is HDFC Bank from India. Among
the Chinese ADRs, the highest M Squared measure (1.62) is by CNOOC. In
comparison, the benchmark MSCI EAFE index has an M Squared measure of
i
m=Li
ht
tp
://
ijb
f.u
um
.e
du
.m
y
84 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
T
ab
le
2
:
3-
Y
ea
r
P
er
fo
rm
an
ce
o
n
a
M
on
th
ly
B
as
is
(
20
03
-2
00
5)
A
vg
S
td
A
lp
ha
A
D
R
s
C
ou
nt
ry
(%
)
(%
)
S
ha
rp
e
S
or
ti
no
B
et
a
M
S
qu
ar
ed
A
lp
ha
t-
st
at
T
re
yn
or
1
A
lu
m
in
um
C
or
po
ra
ti
on
o
f
C
hi
na
C
hi
na
6.
23
16
.6
5
0.
37
0.
86
2.
14
1.
43
2.
48
1.
55
2.
85
2
B
ri
ll
ia
nc
e
C
hi
na
A
ut
om
ot
iv
e
H
ol
di
ng
s
C
hi
na
0.
18
12
.1
5
0.
00
0.
00
0.
96
0.
16
-1
.5
9
-0
.7
8
0.
04
3
C
hi
na
E
as
te
rn
A
ir
li
ne
s
C
hi
na
1.
01
9.
69
0.
09
0.
15
0.
68
0.
46
-0
.2
8
-0
.4
8
1.
27
4
C
hi
na
M
ob
il
e
C
hi
na
2.
41
7.
42
0.
31
0.
51
1.
16
1.
22
0.
30
0.
42
1.
95
5
C
hi
na
P
et
ro
le
um
&
C
he
m
ic
al
C
hi
na
3.
89
10
.8
4
0.
35
0.
82
1.
39
1.
36
1.
41
1.
08
2.
70
6
C
hi
na
T
el
ec
om
C
hi
na
2.
70
9.
81
0.
26
0.
53
1.
63
1.
06
-0
.1
9
0.
50
1.
57
7
C
hi
na
U
ni
co
m
C
hi
na
1.
10
10
.0
4
0.
10
0.
14
1.
02
0.
48
-0
.7
6
-0
.4
1
0.
94
8
C
N
O
O
C
-
C
hi
na
N
at
io
na
l
O
ff
sh
or
e
O
il
C
hi
na
3.
34
7.
62
0.
42
0.
93
0.
41
1.
62
2.
50
1.
07
7.
82
9
G
ua
ng
sh
en
R
ai
lw
ay
C
hi
na
2.
37
8.
35
0.
27
0.
61
0.
94
1.
08
0.
63
0.
35
2.
35
10
H
ua
ne
ng
P
ow
er
I
nt
er
na
ti
on
al
C
hi
na
1.
95
7.
56
0.
24
0.
46
0.
86
0.
98
0.
35
0.
08
2.
10
11
N
et
ea
se
.c
om
C
hi
na
6.
10
18
.7
4
0.
32
0.
65
1.
29
1.
26
3.
78
1.
34
4.
61
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 85
12
P
et
ro
C
hi
na
C
hi
na
5.
10
12
.1
5
0.
41
1.
12
1.
55
1.
58
2.
34
1.
55
3.
20
13
S
in
op
ec
S
ha
ng
ha
i
P
et
ro
ch
em
ic
al
C
hi
na
3.
85
13
.4
9
0.
27
0.
54
1.
69
1.
11
0.
85
0.
87
2.
19
14
Y
an
zh
ou
C
oa
l
M
in
in
g
C
hi
na
3.
64
13
.6
2
0.
26
0.
51
1.
66
1.
05
0.
68
0.
77
2.
10
15
D
r.
R
ed
dy
’s
L
ab
or
at
or
ie
s
In
di
a
0.
74
8.
89
0.
07
0.
10
1.
07
0.
38
-1
.2
1
-0
.6
9
0.
56
16
H
D
F
C
B
an
k
In
di
a
4.
17
8.
42
0.
48
1.
14
1.
08
1.
83
2.
20
1.
54
3.
72
17
IC
IC
I
B
an
k
In
di
a
5.
23
13
.0
0
0.
39
0.
76
1.
56
1.
52
2.
45
1.
51
3.
26
18
In
fo
sy
s
T
ec
hn
ol
og
ie
s
In
di
a
3.
16
11
.8
7
0.
25
0.
41
0.
60
1.
04
2.
01
0.
64
5.
06
19
M
ah
an
ag
ar
T
el
ep
ho
ne
N
ig
am
In
di
a
2.
40
11
.0
0
0.
21
0.
37
0.
58
0.
87
1.
28
0.
30
3.
91
20
R
ed
if
f.
co
m
I
nd
ia
In
di
a
10
.6
3
25
.5
9
0.
41
1.
10
0.
06
1.
58
10
.3
8
2.
04
*
16
4.
51
**
21
S
at
ya
m
C
om
pu
te
r
S
er
vi
ce
s
In
di
a
3.
89
13
.7
0
0.
27
0.
53
1.
46
1.
10
1.
28
0.
87
2.
57
22
V
id
es
h
S
an
ch
ar
N
ig
am
In
di
a
5.
71
18
.5
2
0.
30
0.
74
1.
89
1.
20
2.
37
1.
23
2.
95
23
W
ip
ro
In
di
a
2.
78
10
.9
1
0.
24
0.
39
0.
76
0.
99
1.
34
0.
49
3.
45
M
S
C
I
E
A
F
E
1.
83
3.
51
0.
48
1.
05
1.
00
1.
83
0.
00
0.
00
1.
69
U
S
4
-W
ee
k
T
re
as
ur
y
B
il
l
0.
14
0.
08
0.
00
0.
00
0.
00
0.
14
0.
00
-2
.8
8*
0.
00
*
S
ig
ni
fi
ca
nt
a
t
th
e
5%
l
ev
el
. *
*
D
ue
t
o
th
e
ve
ry
l
ow
b
et
a,
T
re
yn
or
m
ea
su
re
s
ho
ul
d
no
t
be
c
on
si
de
re
d
m
ea
ni
ng
fu
l.
T
ab
le
2
:
3-
Y
ea
r
P
er
fo
rm
an
ce
o
n
a
M
on
th
ly
B
as
is
(
20
03
-2
00
5
(c
o
n
ti
n
u
ed
)
ht
tp
://
ijb
f.u
um
.e
du
.m
y
86 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
1.83. The ADR with the highest Alpha measure is Rediff.com India with Alpha
equal to 10.38, which is signifi cant at the fi ve percent level.
The Chinese ADR with the highest Alpha (3.78) is Netease.com, but
this Alpha is not signifi cant. The Alpha measure of the benchmark MSCI EAFE
Index is, by defi nition, zero. None of the other ADR Alphas is signifi cantly
different from zero. Finally, the ADR with the highest Treynor measure (164.51)
is Rediff.com India. CNOOC is the leading Chinese ADR with a Treynor
measure of 7.82. In comparison, the Treynor measure for the MSCI EAFE Index
is 1.69).
Table 3: 3-Year Ranking (2003-2005)
ADRs Sharpe Rank Sortino Treynor Alpha
Panel A: Whole Sample Country
(M Squared
Rank)
Rank Rank Rank
MSCI EAFE 1 4 19 19
HDFC Bank India 2 1 6 8
CNOOC - China National Off-
shore Oil
China 3 5 2 3
Rediff.com India India 4 3 1 1
PetroChina China 5 2 9 7
ICICI Bank India 6 8 8 5
Aluminum Corporation of China China 7 6 11 4
China Petroleum & Chemical China 8 7 12 10
Netease.com China 9 10 4 2
China Mobile China 10 16 18 18
Videsh Sanchar Nigam India 11 9 10 6
Sinopec Shanghai Petrochemical China 12 12 15 14
Satyam Computer Services India 13 13 13 13
Guangshen Railway China 14 11 14 16
China Telecom China 15 14 20 20
Yanzhou Coal Mining China 16 15 16 15
Infosys Technologies India 17 18 3 9
Wipro India 18 19 7 11
Huaneng Power International China 19 17 17 17
Mahanagar Telephone Nigam India 20 20 5 12
Table continues on the next page
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 87
China Unicom China 21 22 22 22
China Eastern Airlines China 22 21 21 21
Dr. Reddy’s Laboratories India 23 23 23 23
Brilliance China Automotive
Holdings
China 24 24 24 24
Panel B: Chinese Sub-Sample
MSCI EAFE 1 2 11 11
CNOOC - China National Off-
shore Oil
2 3 1 2
PetroChina 3 1 3 4
Aluminum Corporation of China 4 4 4 3
China Petroleum & Chemical 5 5 5 5
Netease.com 6 6 2 1
China Mobile 7 11 10 10
Sinopec Shanghai Petrochemical 8 8 7 6
Guangshen Railway 9 7 6 8
China Telecom 10 9 12 12
Yanzhou Coal Mining 11 10 8 7
Huaneng Power International 12 12 9 9
China Unicom 13 14 14 14
China Eastern Airlines 14 13 13 13
Brilliance China Automotive
Holdings
15 15 15 15
Panel C: Indian Sub-Sample
MSCI EAFE 1 3 9 9
HDFC Bank 2 1 4 4
Rediff.com India 3 2 1 1
ICICI Bank 4 4 6 2
Videsh Sanchar Nigam 5 5 7 3
Satyam Computer Services 6 6 8 8
Infosys Technologies 7 7 2 5
Wipro 8 8 5 6
Mahanagar Telephone Nigam 9 9 3 7
Dr. Reddy’s Laboratories 10 10 10 10
Table 3: 3-Year Ranking (2003-2005)
ht
tp
://
ijb
f.u
um
.e
du
.m
y
88 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
Table 3 Panel A reports the rankings of all the ADRs. The Treynor and
Alpha ranks in Table 3 indicate that, 18 ADRs have returns (adjusted for
systematic risk) that, exceed the risk-adjusted returns of the MSCI EAFE Index.
The Sharpe ranks indicate that none of the ADRs has returns (adjusted for total
risk) that exceed the risk-adjusted returns of the MSCI EAFE Index. The Sortino
ranks indicate that only HDFC Bank (India), PetroChina, and Rediff.com India
have returns (adjusted for downside risk) that exceed the risk-adjusted returns
of the MSCI EAFE Index. The ranking based on the M Squared measure is
identical to the ranking based on the Sharpe measure. However, the M Squared
measure enables us to draw some inferences, which cannot be drawn from the
Sharpe measure (or, as a matter of fact, from any other measure), and these are
detailed at the end of this section. Panel B and Panel C show the rankings for the
Chinese and Indian sub-samples, respectively.
Table 4 Panel A reports the average returns that accrue to the whole
sample of ADRs with and without risk-adjustment. The risk-adjustment is
performed by using the MSCI EAFE Index as the benchmark. The returns are
annualized for the convenience of investors. This is done by compounding the
monthly mean returns over twelve periods. In that panel, Rediff.com India,
which ranks fi rst based on unadjusted returns, falls back to rank four on the
basis of returns adjusted for risk. Aluminum Corporation of China ranks second
on the basis of unadjusted returns, but falls back to rank seven based on returns
adjusted for risk. Netease.com, which ranks third on the basis of unadjusted
returns, falls back to rank nine on the basis of returns adjusted for risk. On the
other hand, MSCI EAFE, which ranks 20th on an unadjusted basis, ranks fi rst
when the returns are adjusted for risk. HDFC Bank (India), which ranks seventh
on an unadjusted basis, ranks second when the returns are adjusted for risk.
CNOOC, which ranks 12th on an unadjusted basis, ranks third when the returns
are adjusted for risk. The leverage factor for this ADR is 0.46, which implies
that an investor, who is comfortable with bearing the same level of risk as in
the benchmark MSCI EAFE index, could unlever the ADR (lend 54 percent
of her down payment, if possible, at the risk-free rate of interest and invest the
rest in the ADR) and thereby attain an annual return level of 21.22 percent. The
example below details how this return can be obtained.
Consider an investor who would like to earn superior returns on an ADR
and, at the same time, bear only an average level of risk. In this context, the
average level of risk is measured by the standard deviation of the benchmark
MSCI EAFE index, which is 3.51 percent on a monthly basis. Now consider the
following investment strategy: Suppose that the investor has $1,000 to invest.
The investor could lend $540 and invest $460 in CNOOC. The end of month
return from the ADR portion of the portfolio will be $460 x 0.0334 = $15.36.
Suppose that the loaned funds were given at the monthly risk-free rate of 0.14
percent. In that case, the loaned funds will bring $540 x 0.0014 = $0.76. The
portfolio return is $15.36 + 0.76 = $16.12, which is a return of 1.61 percent on a
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 89
T
ab
le
4
:
3-
Y
ea
r
A
nn
ua
li
ze
d
P
er
fo
rm
an
ce
:
U
na
dj
us
te
d
an
d
A
dj
us
te
d
fo
r
R
is
k
A
D
R
s
U
na
dj
us
te
d
U
na
dj
us
te
d
A
dj
us
te
d
A
dj
us
te
d
L
ev
er
ag
e
A
nn
ua
li
ze
d
R
an
k
A
nn
ua
li
ze
d
R
an
k
F
ac
to
r
P
an
el
A
:
W
h
ol
e
S
am
p
le
C
ou
nt
ry
R
et
ur
ns
(
%
)
R
et
ur
ns
(
%
)
M
S
C
I
E
A
F
E
24
.3
5
20
24
.3
5
1
1.
00
H
D
F
C
B
an
k
In
di
a
63
.3
1
7
24
.2
4
2
0.
42
C
N
O
O
C
-
C
hi
na
N
at
io
na
l
O
ff
sh
or
e
O
il
C
hi
na
48
.2
5
12
21
.2
2
3
0.
46
R
ed
if
f.
co
m
I
nd
ia
In
di
a
23
6.
08
1
20
.7
5
4
0.
14
P
et
ro
C
hi
na
C
hi
na
81
.7
3
6
20
.6
8
5
0.
29
IC
IC
I
B
an
k
In
di
a
84
.4
2
5
19
.8
4
6
0.
27
A
lu
m
in
um
C
or
po
ra
ti
on
o
f
C
hi
na
C
hi
na
10
6.
56
2
18
.5
6
7
0.
21
C
hi
na
P
et
ro
le
um
&
C
he
m
ic
al
C
hi
na
58
.1
1
8
17
.5
9
8
0.
32
N
et
ea
se
.c
om
C
hi
na
10
3.
62
3
16
.2
4
9
0.
19
C
hi
na
M
ob
il
e
C
hi
na
33
.0
6
16
15
.6
3
10
0.
47
V
id
es
h
S
an
ch
ar
N
ig
am
In
di
a
94
.6
1
4
15
.3
8
11
0.
19
S
in
op
ec
S
ha
ng
ha
i
P
et
ro
ch
em
ic
al
C
hi
na
57
.2
7
10
14
.1
4
12
0.
26
S
at
ya
m
C
om
pu
te
r
S
er
vi
ce
s
In
di
a
58
.0
2
9
14
.0
9
13
0.
26
G
ua
ng
sh
en
R
ai
lw
ay
C
hi
na
32
.4
0
18
13
.7
6
14
0.
42
C
hi
na
T
el
ec
om
C
hi
na
37
.6
5
15
13
.4
8
15
0.
36
Y
an
zh
ou
C
oa
l
M
in
in
g
C
hi
na
53
.5
1
11
13
.2
9
16
0.
26
In
fo
sy
s
T
ec
hn
ol
og
ie
s
In
di
a
45
.2
0
13
13
.1
6
17
0.
30
W
ip
ro
In
di
a
38
.9
1
14
12
.5
8
18
0.
32
H
ua
ne
ng
P
ow
er
I
nt
er
na
ti
on
al
C
hi
na
26
.0
8
19
12
.4
7
19
0.
46
M
ah
an
ag
ar
T
el
ep
ho
ne
N
ig
am
In
di
a
32
.9
5
17
10
.8
9
20
0.
32
C
hi
na
U
ni
co
m
C
hi
na
14
.0
7
21
5.
91
21
0.
35
C
hi
na
E
as
te
rn
A
ir
li
ne
s
C
hi
na
12
.7
8
22
5.
62
22
0.
36
D
r.
R
ed
dy
’s
L
ab
or
at
or
ie
s
In
di
a
9.
25
23
4.
65
23
0.
40
B
ri
ll
ia
nc
e
C
hi
na
A
ut
om
ot
iv
e
H
ol
di
ng
s
C
hi
na
2.
23
24
1.
88
24
0.
29
T
a
b
le
c
o
n
ti
n
u
es
o
n
t
h
e
n
ex
t
p
a
g
e
ht
tp
://
ijb
f.u
um
.e
du
.m
y
90 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
P
an
el
B
:
C
h
in
es
e
S
u
b
-S
am
p
le
M
S
C
I
E
A
F
E
24
.3
5
12
24
.3
5
1
1.
00
C
N
O
O
C
-
C
hi
na
N
at
io
na
l
O
ff
sh
or
e
O
il
48
.2
5
7
21
.2
2
2
0.
46
P
et
ro
C
hi
na
81
.7
3
3
20
.6
8
3
0.
29
A
lu
m
in
um
C
or
po
ra
ti
on
o
f
C
hi
na
10
6.
56
1
18
.5
6
4
0.
21
C
hi
na
P
et
ro
le
um
&
C
he
m
ic
al
58
.1
1
4
17
.5
9
5
0.
32
N
et
ea
se
.c
om
10
3.
62
2
16
.2
4
6
0.
19
C
hi
na
M
ob
il
e
33
.0
6
9
15
.6
3
7
0.
47
S
in
op
ec
S
ha
ng
ha
i
P
et
ro
ch
em
ic
al
57
.2
7
5
14
.1
4
8
0.
26
G
ua
ng
sh
en
R
ai
lw
ay
32
.4
0
10
13
.7
6
9
0.
42
C
hi
na
T
el
ec
om
37
.6
5
8
13
.4
8
10
0.
36
Y
an
zh
ou
C
oa
l
M
in
in
g
53
.5
1
6
13
.2
9
11
0.
26
H
ua
ne
ng
P
ow
er
I
nt
er
na
ti
on
al
26
.0
8
11
12
.4
7
12
0.
46
C
hi
na
U
ni
co
m
14
.0
7
13
5.
91
13
0.
35
C
hi
na
E
as
te
rn
A
ir
li
ne
s
12
.7
8
14
5.
62
14
0.
36
B
ri
ll
ia
nc
e
C
hi
na
A
ut
om
ot
iv
e
H
ol
di
ng
s
2.
23
15
1.
88
15
0.
29
P
an
el
C
:
In
d
ia
n
S
u
b
-S
am
p
le
M
S
C
I
E
A
F
E
24
.3
5
9
24
.3
5
1
1.
00
H
D
F
C
B
an
k
63
.3
1
4
24
.2
4
2
0.
42
R
ed
if
f.
co
m
I
nd
ia
23
6.
08
1
20
.7
5
3
0.
14
IC
IC
I
B
an
k
84
.4
2
3
19
.8
4
4
0.
27
V
id
es
h
S
an
ch
ar
N
ig
am
94
.6
1
2
15
.3
8
5
0.
19
S
at
ya
m
C
om
pu
te
r
S
er
vi
ce
s
58
.0
2
5
14
.0
9
6
0.
26
In
fo
sy
s
T
ec
hn
ol
og
ie
s
45
.2
0
6
13
.1
6
7
0.
30
W
ip
ro
38
.9
1
7
12
.5
8
8
0.
32
M
ah
an
ag
ar
T
el
ep
ho
ne
N
ig
am
32
.9
5
8
10
.8
9
9
0.
32
D
r.
R
ed
dy
’s
L
ab
or
at
or
ie
s
9.
25
10
4.
65
10
0.
40
T
ab
le
4
:
3-
Y
ea
r
A
nn
ua
li
ze
d
P
er
fo
rm
an
ce
:
U
na
dj
us
te
d
an
d
A
dj
us
te
d
fo
r
R
is
k
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 91
monthly basis or 21.13 percent (slightly off the 21.22 percent in Table 4 due to
rounding) on an annual basis. Note that the monthly risk of the portfolio is 0.46
x 7.62 = 3.51 percent, which is the same as the monthly standard deviation of the
benchmark MSCI EAFE Index. This investment strategy, therefore, enables the
investor to earn superior returns for an average level of risk. It may be noted that
the above example assumes that the returns on risk-free US treasury bills are not
correlated with the returns on the ADR.
5. Conclusion
ADRs represent a convenient vehicle to access emerging markets such as China
and India for international investors who are contemplating global portfolio
selection. These securities are structured to serve the needs of both investors
and issuers. There are 161 ADRs from the China-India region that are listed
on U.S. markets and they provide a menu of investment opportunity across
diverse industry groups. This study examines the nature of these ADRs in order
to identify the depositary bank, sponsorship status, industry classifi cation, and
market listing.
Prior research has examined the performance of individual Chinese and
Indian stocks in local currencies. However, risk-adjusted returns reported
in terms of US dollars are more useful to international investors for security
selection and portfolio construction. In addition, from the global investor’s point
of view, the instrument of choice for accessing Chinese and Indian stock markets
is the ADR, not the underlying stock itself. Hence, there is need for rigorous
evaluation of the performance of these ADRs using metrics grounded in modern
portfolio theory. This study contributes to academic and practitioner literature
by meeting this need.
In order to facilitate comparison with international stock market
performance, this study uses the Morgan Stanley Capital International EAFE
Index to evaluate the risk-adjusted returns of Chinese and Indian ADRs. Some
of these ADRs have unadjusted returns which are high, but once risk is factored
in, the adjusted returns are less attractive. On the other hand, some ADRs with
modest returns may be quite attractive to international investors, when their
returns are adjusted upward for low risk. Global investors may want to examine
each of these securities in detail, in order to evaluate them further for possible
inclusion in an investment portfolio. Of course, the contribution of a security to
portfolio return and risk should matter more to the global investor than the return
and risk of an individual security.
This study provides empirical evidence on the risk and return characteristics
of ADRs from China and India. It would be benefi cial to update this information
on a continuing basis, in order to provide ongoing documentation to international
investors who seek to diversify into these markets. Future research could focus
on decoupling the return to these ADRs into its constituent components: risk-
adjusted return in the domestic currency and fl uctuation in the exchange rate.
ht
tp
://
ijb
f.u
um
.e
du
.m
y
92 Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93
Author statement: The submitting author is Ajay Samant, National City
Endowed Chair in Finance, Western Michigan University, Kalamazu, Michigan,
USA. E-mail: ajay.samant@wmich.edu. Onur Arugaslan is an Associate
Professor at the same University.
References
Aggarwal, R., Dahiya, S., and Klapper, L. F. (2005). American Depositary
Receipts (ADR) Holdings of U.S. based emerging market funds. World
Bank Policy Research (Working Paper No. 3538).
Alexander, G. J., Cheol S. E., and Janakiramanan S. (1987). Asset pricing and
dual listing on foreign capital markets: A note. Journal of Finance, 42,
151-158.
Alexander, G. J., Cheol, S. E., and Janakiramanan S. (1988). International
listings and stock returns: Some empirical evidence. Journal of Financial
and Quantitative Analysis, 23, 135-151.
Chang, E. C., and Lewellen, W. G. (1984). Market timing and mutual fund
investment performance. Journal of Business, 57(1), 57-72.
Eichler, S., and Maltritz, D. (2008). Currency crisis prediction using ADR market
data - An options-based approach. EFA 2008 Athens Meetings Paper.
Henrikkson, R.D., and Merton, R.C. (1981). On market timing and investment
performance II: Statistical procedures for evaluating forecasting skills.
Journal of Business, 54(4), 513-533.
Jaiswal-Dale, Ameeta and Jithendranathan, Thadavillil, (2001). Fluctuating
returns of dual listings: Domestic and ADR markets. EFMA 2001 Lugano
Meetings Paper.
Jayaraman, N., Shastri K., and Tandon K., (1993). The impact of international
cross-listings on risk and return: The evidence from American Depositary
Receipts. Journal of Banking and Finance, 17(1), 91-103.
Jensen, M.C. (1968). The performance of mutual funds in the period 1945-64.
Journal of Finance, 23(2), 389-416.
Kon, S. J., and Jen, F. C. (1979). The investment performance of mutual funds:
An empirical investigation of timing, selectivity, and market effi ciency.
Journal of Business, 52(2), 263-289.
Modigliani, F., and Modigliani, L. (1997). Risk-adjusted performance. Journal
of Portfolio Management, 23(2), 45-54.
Offi cer, D., and J. Ronald H. (1987). ADRs: A substitute for the real thing?
Journal of Portfolio Management, 61-65.
Pedersen, C.S., and Satchell, S.E., (2002). On the foundation of performance
measures under asymmetric returns. Quantitative Finance, 2(3), 217-223.
Umutlu, Mehmet, Salih, Aslihan A., and Akdeniz, L. (2007). Do ADR listings
affect the dynamics of volatility in emerging markets? SSRN Working
Paper.
ht
tp
://
ijb
f.u
um
.e
du
.m
y
Risk-adjusted returns of American depositary receipts on Chinese and Indian Stocks: 77-93 93
Saudagaran, Shahrokh M. (1988). An investigation of selected factors infl uencing
the decision to list on foreign stock exchanges. Journal of International
Business Studies, 101-128.
Sharpe, W. F. (1966). Mutual fund performance. Journal of Business, 39(1),
119-138.
Solnik, B.H., and McLeavey, D., (2004). International investments (5th ed.).
Reading, MA: Addison-Wesley.
Sortino, F. A., and Price, L. N. (1994, Fall). Performance measurement in a
downside risk framework. Journal of Investing, 59-65.
Treynor, J.L. (1965). How to rate management of investment funds. Harvard
Business Review, 43(1), 63-75.
ht
tp
://
ijb
f.u
um
.e
du
.m
y
ht
tp
://
ijb
f.u
um
.e
du
.m
y